It looks like a slow economic recovery is on the way! (but that doesn’t necessarily mean we’re out of the woods)

At long last, there are some pretty solid signs the economy may recover soon.

This week, both the weekly initial jobless claims report and the monthly unemployment report showed improvement. Initial jobless claims have been high, but declining, which usually happens several months before the economy starts growing again. The monthly unemployment report showed high and growing unemployment, but with much fewer jobs being cut by employers.

These reports aren’t saying the employment situation is getting better, just that it’s getting bad less quickly. But, that’s always the first necessary step to an economic recovery.

You see, unemployment almost always peaks long after the economy starts growing again, so it’s normal for the employment situation to be getting less bad when the economy turns.

Not surprisingly, the stock market anticipated this situation. The market has been rallying since March, showing once again its predictive ability. But keep in mind, the stock market has forecast 9 of the last 5 recessions and 9 of the last 5 recoveries.

That’s not a typo, the stock market frequently tanks or moves up falsely, indicating things are getting worse or improving when that isn’t the case. In other words, it’s not a great indicator by itself, but it is a good indicator in concert with others.

Adding to information from employment and the stock market, the Chinese government is working hard to stimulate its economy, and it looks like those efforts have been successful so far. Unlike the U.S. government, the Chinese government actually has money to stimulate their economy instead of simply borrowing from others to stimulate. This doesn’t mean the Chinese government’s efforts are efficient or even sustainable over the long run, but for now it’s working, and they have a lot of money they can spend to get things going.

Putting these data points together, along with retail sales, copper prices, industrial activity, inventory levels, and so forth, it looks like an economic recovery is on the way.

How will this impact investors? Good question. As usual, I don’t really know what will happen in the short run.

This could be a V recovery, a sharp economic rebound, a U recovery, a long slow period followed by faster growth, a W recovery, a sharp rebound followed by another slowdown followed by a sustainable recovery, or an L “recovery,” where we don’t really recover so much as things don’t continue getting worse. An L recover is really a U recovery where the base of the U is very, very wide. Think Japan over the last…well…20 years.

If a V recovery is in the works, the stock market could just keep going up. It won’t move straight up, because conflicting information will cause temporary setbacks, but on the whole it will not reach new bottoms and will trend upward over time. That would be the most fun, but I believe it’s the least likely scenario. It’s possible, though.

A U or L recovery would mean the stock market has gotten ahead of itself, and if companies start pre-announcing that things don’t look that great for the 3rd and 4th quarter, the market would probably tank. The market’s recent move indicates V or W with strong growth and earnings beginning late this year or early next. If that doesn’t happen, market participants will be very disappointed and prices will decline, perhaps significantly.

If a W recovery is in the works, the market could go up for the next year or more, only to crash again as the current nascent recovery turns out to be a false dawn followed by another recession. Unfortunately, I see this scenario as quite likely. Government stimulus may lead to higher inflation and high commodity prices, which could send the economy right back into recession.

My guess, and I’ll admit its no better than that, is that we are in a W recovery. That means enjoy the rally for the time being, but be prepared for another downdraft in a year or two. This may sound unpleasant, but it will produce many opportunities to make money both on the up and the downside. That’s what happened in the late 1970’s and early 1980’s. There was a lot of money to be made on commodities during the turmoil, and then the greatest bull market of all time began in 1982.

The next most likely scenario, in my opinion, is a U/L recovery. This would be no fun for most investors, but work out fine–over the long run–for the prepared. It would provide a lot of false dawn rallies and several exploitable downdrafts. That’s what the 1930’s and 1970’s looked like, as well as Japan over the last 20 years.

The V recovery, which I consider least likely, would, I believe, look like the recoveries we saw after the late 1990-91 recession and the 2001 recession. In both cases, the market didn’t really take off until a couple of years after the economy left recession. In both cases, they were referred to as “job-less” recoveries, with economic growth and very slow employment improvement.

As you may have noticed, I didn’t include any scenario where the market just takes off into a 20 year bull market with annualized returns of 20%. That’s because I consider such a scenario so unlikely as to be hardly worth mentioning. It’s possible, but I wouldn’t bet on it.

It feels a lot better to be talking about recovery than it did talking about how bad things were last November or March. However, I believe the market may be getting ahead of itself in predicting robust growth by year end. It might be a good time to take some profits and sit on a little bit extra cash.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.